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Can liquidators distribute money before a tax assessment has been issued?

In a win for creditors of insolvent companies, on 10 December 2015 the High Court determined that the obligation of a liquidator under section 254(1)(d) of the Income Tax Assessment Act 1936 (Cth) (1936 Act) to retain sufficient funds to pay tax on assets realised during the winding up only arises after a tax assessment has been made. If the funds are distributed prior to a tax assessment being made, then the obligation does not arise.

This decision represents a definitive return to market understanding and practice, and makes commercial life a little easier for both liquidators and (by analogy) receivers appointed by secured creditors.

Further detail follows below.

Background to the litigation

During the course of winding up Australian Building Systems Pty Ltd (ABS), Liquidators disposed of real property that realised a capital gain of $1.12 million. The Liquidators sought a private ruling on behalf of ABS, as to whether or not the Liquidators were required (by section 254 of the 1936 Act) to retain a portion of the sale proceeds (either on the crystallisation of the tax liability or upon an assessment being issued) for the purpose of satisfying the potential tax liability.

The Commissioner's view was that section 254 of the 1936 Act imposed a personal liability on the Liquidators to retain monies from the proceeds even before a tax assessment was made in relation to ABS. The Liquidators disagreed with the Commissioner and appealed to the Federal Court for declaratory relief.

Both the Federal Court and the Full Federal Court agreed with the taxpayer and held that, in the absence of a tax assessment, section 254 of the 1936 Act did not impose an obligation on a liquidator to retain funds. The Commissioner obtained special leave to appeal those decisions to the High Court.

In its decision released on 10 December 2015, the High Court agreed with the conclusions reached by the Federal Court and the Full Federal Court, and found for the Liquidators.

Key issue

The key question decided upon by the High Court was whether section 254(1)(d) imposes an obligation on every agent and trustee (including liquidators) to retain funds to pay a future tax liability before a tax assessment is made. Section 254(1)(d) states (emphasis added):

He or she is… required to retain… out of any money which comes to him or her in his or her representative capacity so much as is sufficient to pay tax which is or will become due….

Federal Court and Full Court decision

The Federal Court decision (per Logan J) relied on the decision of the High Court in Bluebottle UK Ltd v Deputy Commissioner of Taxation (2007) 232 CLR 598 (Bluebottle) which analysed a similarly worded provision, section 255(1)(b) of the 1936 Act, to conclude that the phrase “tax which is or will become due” (in section 254(1)(d)) means "assessed" and "owing".

This reasoning was approved by Davies J in the Full Federal Court decision. The other judges of the Full Federal Court (Edmonds and Collier JJ) also agreed with Logan J's Federal Court decision, but noted that section 254 was a collecting section (and not a section that imposed tax).

High Court decision

The majority of the High Court in Commissioner of Taxation v Australian Building Systems Pty Ltd (in liquidation); Commissioner of Taxation v Muller and Dunn as Liquidators of Australian Building Systems Pty Ltd (in liquidation) [2015] HCA 48 (per French CJ and Kiefel J in a joint decision, and Gageler J) held that the obligation to retain an amount from funds to pay tax under section 254(1)(d) only arises after a tax assessment has been made.

French CJ and Kiefel J said that the High Court's considerations in Bluebottle in relation to section 255(1)(b) were equally applicable to the retention requirement under section 254(1)(d). That is, section 254 only applies to tax that is assessed and owing. Gageler J was persuaded that the retention obligation in section 254 was limited to retaining money after an assessment was made because this approach:

fits in with the structure of section 254;

provides certainty as to how much an agent or trustee is authorised and required to retain;

places agents on an even footing with other taxpayers (as businesses are not normally obliged to quarantine monies for the future payment of tax);

provides a level of protection to agents and trustees; and

minimises any potential conflicts between liquidators' obligations under section 254 and the rights of creditors under Chapter 5 of the Corporations Act 2001 (Cth).

The High Court's decision means that the Commissioner will no longer be able to assert that section 254 gives it priority over secured creditors. It is likely that the Commissioner will withdraw (or at a minimum, review) its draft determinations TD 2012/D6 and TD 2012/D7 which are inconsistent with yesterday's High Court decision.

Other questions decided

The Commissioner made two other submissions to the High Court, which were uncontested by the Respondents.

Firstly, the Commissioner argued that the majority of the Full Court had erred in finding that the Liquidator was a "trustee of a trust estate" for the purposes of the trust taxing provisions set out in Division 6 of the 1936 Act. The High Court agreed with the Commissioner's submissions and held that there was no trust estate between the Liquidator and ABS.

Secondly, the Commissioner argued that the majority of the Full Court had erred by construing section 254 as a collecting provision that only operates where the agent or trustee is otherwise assessable. The Commissioner argued that, although ABS was principally liable to pay tax on the capital gain, this did not change the fact that the Liquidators had a liability to pay tax imposed by section 254(1)(a) of the 1936 Act, which states that an agent or trustee, "shall be answerable as taxpayer… for the payment of tax" on income, profits or gains derived by him or her in his or her representative capacity.

The High Court agreed, and held that section 254(1) was both a collecting provision and a liability-imposing provision. The High Court stated (per Keane J) that the language of section 254(1)(b) creates a personal liability in an agent or trustee to pay tax even though this liability is ancillary to that of the principal or beneficiary.